Russian Economy in Limbo

After being hit hard by the global financial crisis, Russian economy finds itself in a difficult situation. It needs to somehow find ways to return to sustainable economic growth, beyond just plain post-crisis recovery. However, it appears that the factors which have been driving the impressive growth of the Russian economy in 2000-2008, have gone and are not likely to restore any time in the near future. Therefore, to be able to return to economic growth, Russia needs a considerable revision of its economic policies towards stimulating investment and better efficiency, which is, in turn, confronted by the nature of the rent-seeking political and governance model that had developed in Russia under Vladimir Putin’s rule. Massage Happy Ending straight talk on Happy Ending.

Russian economic growth of the last decade can be clearly divided into two historical phases. During the first phase, which roughly corresponds to Vladimir Putin’s first presidential term, the growth was based on the post-crisis recovery, being driven by the effects of sharp rouble depreciation and by availability of substantial unutilized manufacturing capacities. Significant contribution to growth was the increase of international commodity prices (Urals crude oil prices have increased to average $24,7/bbl in 2000-2002 from average $16,7/bbl during 1990s), as well as increase of physical volumes of commodity exports.

However, by 2002-2003, the potential positive influence of these factors on economic growth had largely expired for the time being, and there was a consensus among many experts that further GDP growth rates would slow down over years from 5-7% to 3-4% and further to no more than 1-2%. To ensure higher growth rates, it was widely believed that more fundamental policy measures would be required – that is, stimulating fixed investment through creation of more favorable investment climate, and stimulating growth of labor productivity and efficiency of the Russian economy through structural reforms of the “non-market sector” (as defined by Yevgeny Yasin) – privatization of state-owned enterprises, restructuring of infrastructure monopolies, etc.

The Government’s comprehensive economic reform program launched in 2000 and pursued further with regular updates (known as the “Gref program”) seemed to be aimed at just that. However, its implementation during 2000-2007 had turned out to be fragmentary and inconsistent, and brought little effect, as fixed investment remained almost flat at around 20% of GDP, compared to well above 40% of GDP in China (up from 35% in 2000) and above 30% of GDP in India (up from 25% in 2000), where economic growth was really investment-based. Situation with labor productivity remained no better: during all of the recent decade, it had grown, too, but almost two times slower than the real personal income.

During 2003-2005, economic growth had temporarily boosted again to 6-7% a year due to a sharp increase in Urals price – to an average of $27,3/bbl in 2003, $34,4/bbl in 2004, and the previously unimaginable $50/bbl in 2005. This had undermined substantially larger capabilities for continuing rent-based economic growth without reliance on potentially painful structural reforms. By end-2004, newly created Government’s Stabilization Fund had reached RUR 500 billion.

It is important that, at that time, more stimulus had emerged for the Government to slow down with structural reform agenda: on one hand, its own appetite for control over strategic assets and partial renationalization of the economy (marked by takeovers of Yukos and other formerly private-owned companies, which had totally contributed to decline in the share of GDP produced by the private sector from 70% to 65%, according to EBRD, — a pattern quite uncommon for other transition economies), and, on the other hand, the grim perspective of social instability and protests. The latter perspective had became visible during the early 2005 social unrest related to the Government’s efforts targeted to monetize social benefits.

In any case, in 2005-2008, a new factor supporting economic growth in Russia had emerged, apart from the growing revenues from oil exports, once more supporting the rent-oriented policies, and allowing to postpone the necessary structural reforms: the massive inflow of foreign capital. Before 2005, Russia had been a net exporter of capital – more capital had fled the country than was invested into it. However, in 2005, the situation have changed – in 2005, the net inflow of capital was yet relatively insignificant – USD 1,1 billion, but that had marked the change of the multiple-year trend. Further figures were more impressive: in 2006, net capital inflow had comprised USD 41,6 billion, in 2007 – USD 82,3 billion, during first half of 2008 – USD 17 billion.

That period of excessive global liquidity and underestimated risks was marked by large flow of Western capital to all major emerging market economies; however, the untypical situation for Russia was that, unlike, say, other BRIC countries, capital came mostly in form of loans to Russian corporations and banks (60-70%), not direct foreign investments (see Rogov, 2008).

The latter factor was an indirect indication of the lack of confidence of foreign investors in direct investments in Russia, as well as high direct investment entry barriers imposed by the new Government policies of renationalization and seeking control over strategic sectors of the economy. It was also an indirect indication that investors rather preferred debt investment as compared to equity investments, because they believed that Government would use its impressive accumulated financial reserves to directly or indirectly bail out potentially problematic debtors, should the problems emerge (which was proven true during the active phase of the latest crisis in 2008-2009). Government’s financial reserves in this case were largely considered as a pledge under this rapid credit expansion.

As a result, total foreign debt of Russian corporate and banking sector had skyrocketed from around USD 110 billion by January 1st, 2005, to USD 505 billion by October 1st, 2009.

This foreign credit expansion onto Russian market was the main source of economic growth in Russia in 2005-2008 (the “second phase” of growth as defined in this working paper), outpassing the oil export revenue as major contributor to growth, and turning down earlier pessimistic forecasts about growth slowdown.

However, this model was clearly unsustainable, as the capital had started to rapidly exit the country, along with other emerging markets, starting from H2 2008, along with the active phase of the global financial crisis, leaving Russia with huge corporate foreign debt. Capital flight began in second half of 2008, when USD 150 billion had fled the country, and continued through 2009, when net outflow had reached USD 52 billion, and, so far, through the first quarter of 2010 (net capital outflow USD 13 billion). In total, more foreign capital have left the country during the recent crisis, than came into Russia earlier in 2005-2008.

The massive outflow of liquidity had forced the Government to use its accumulated reserves to substitute it. Russian Central Bank had lost about USD 200 billion of its hard currency reserves trying to slow down the sharp depreciation of rouble and thus ease the repay of some of the foreign currency loans for Russian banks. Government had committed to keep and even slightly increase its spending to help the economy: new Russian federal budgets for 2009 and 2010 had been adopted with deficit. In 2009, the actual deficit comprised 5,9% of GDP, and it was planned in the amount of 6,8% of GDP for 2010 (the actual figure is now predicted to be slightly lower – 5,1% of GDP, which is nevertheless a high deficit in itself).

Such policy, however, again is not sustainable, and had already led to rapid shrinking of the Government’s financial reserves. Minfin’s Reserve Fund (the successor fund of the Stabilization fund) had shrunk from USD 137 billion by January 1st, 2009, to just USD 40 billion by May 1st, 2010, and will be fully spend in the upcoming months, should it further be used to finance the huge budget deficit. There’s also the Minfin’s Future Generations Fund (another part of the split former Stabilization fund) in the amount of around USD 90 billion, but substantial part of it is committed with the pension system spending, and in any case, it cannot prolong the life of reserve-based deficit-financing policy for more than a year or so.

All this have led finance Minister Kudrin to openly admit in April 2010 that Russia will have to reconsider the budget-financed recovery policies, and will have to cut budget spending by 20% by 2015.

It is quite remarkable that even the relatively high Urals crude oil prices — $75/bbl in first quarter of 2010, well above 2000-2008 average of $45,6/bbl – did not help to save the Government’s Reserve fund from major shrinking: during January-April 2010, it had shrunk by one-third, from USD 60 billion by January 1st, 2010, to USD 40 billion by May 1st, 2010. This means that, given the current size of Government and the extent of its direct involvement in recovery efforts, even if the oil prices would stay at $70-80/bbl, that would not be enough to avoid large budget deficits and further erosion of the state’s financial reserves, not to mention any opportunity for new reserve building.

So, when the reserves are expired, what next?

It is quite clear that even the massive Government aid (the total estimates of Government’s anti-crisis aid vary from 3% of GDP in 2009 to 7% of GDP (Alexashenko, 2010), if the measures taken in end-2008 are considered) did not help to prevent the major plunge of the Russian economy. GDP in 2009 had contracted by7,9% — largest contraction in 15 years, since 1994, even outpassing the 1998 default (when GDP had contracted by just 5,3%). During first quarter of 2010, Russian GDP had climbed by moderate 2,9% compared to disastrous Q1 2009, when GDP had plunged by gloomy 9,8% as compared to Q1 2008. Most indicators – industrial output, investment, entrepreneurial activity – indicate that, despite some formal recovery as compared to disastrous numbers of the worst months of crisis of early 2009, the economy mostly finds itself in stagnation, “hanging” at the levels of early 2007 or likewise.

It is quite clear that massive Government spending, leading to rapid erosion of Government’s financial reserves, are not particularly helping to move the economy forward. And quite soon, even this opportunity will be expired.

Again, what is left out there to stimulate return to economic growth?

It is quite clear that, due to ongoing global financial troubles, foreign capital will not return to Russia – at least not any more in the form of massive cheap loans as experienced in 2005-2008. In fact, capital is still exiting the country, despite constant rosy forecasts by Government officials about the “expectations of turnaround” of the trend. Corporate debt remains high: according to the Russian Central Bank, it had comprised over USD 430 billion by April 1st, 2010, and had started to climb from second half of 2009. Foreign loans comprise over two-thirds of this debt.

As indicated above, oil prices also can hardly be considered as a potential source of growth – at the levels of $70-80/bbl they are not sufficient for that, given the current enormous size of the government. General government spending remains at the level of 40-41% of GDP, compared to 33-36% at pre-crisis levels. It should be also mentioned that the Russian oil & gas industry is confronted by totally new level of expenses related to development of new greenfield oil & gas provinces and fields, something unexperienced in early 2000s. This means that this sector can not be considered any more as the same source of easy rents as during the past decade, when the bulk of production was delivered from depreciated old fields with little investment and operational costs. The debate on full lifting of export duty on oil exported through the hew Eastern Siberia – Pacific oil pipeline, as well as lifting of the export duties on gas to be exported via Nord Stream and South Stream gas pipelines, is a clear illustration of that.

There’s always a possibility that oil prices may rise above $100/bbl and further upwards again, providing the Russian Government with renewed opportunity for continuing its dirigisté economic course. However, that perspective is quite far from being certain, given the current situation at the international oil market, where there’s clear excess of spare oil production capacity, that is forecasted to stay for as long as well beyond 2015 even in the optimistic case of global economic recovery (more detailed discussion on that to follow). New sharp rise in global oil prices can be considered as a scenario for analyzing Russia’s economic future, but the probability of that scenario does not appear to be high.

During the previous years, it was debated that the growing Government spending (particularly investment-related) may also become a new source of growth and modernization of the economy, but the actual consequences of sharp increase in federal spending in 2006-2010 do not support this theory. Government spending turns out to be quite inefficient and not delivering any practical results in terms of stimulating economic growth that can be in any way comparable with the private sector.

The only source of potential resuming of significant economic growth in Russia may still be the increase in the efficiency of the economy, growth in productivity, and stimulation of fixed investment, – the agenda abandoned several years ago together with the whole set of much needed structural reforms. However, that would require a considerable revision of the mainstream Government’s policies as compared to the period: changing renationalization and creation of state-owned “national champions” to privatization, restrictive attitude towards FDI in strategic sectors of the economy to favorable, radically reducing size and regulatory powers of the government instead of further expanding them as currently pursued, ensuring true independence of judiciary and private property protection, etc.

It is not clear whether the Russian authorities will finally have the will to consider fundamentally changing the economic (and political?) course. However, if they would not do so, there appear to be no more “silver bullets” to rely on for Russian economic growth similar to those which have boosted Russia’s economy during the past decade (growth in oil export revenues and massive inflow of chap foreign loans). However, if the new “silver bullets” will not be found, and the current dirigisté course will not be radically changed, Russian economy faces a very uncertain perspective – most likely, a very low growth or stagnation environment for years.

These policy crossroads – between “business-as-usual” dirigisté course and radical change of the economic policy agenda – will shape the Russia’s economic future for the upcoming decade to 2020. In the end, the three scenarios suggested for consideration are as follows: